Income Risk, Income Mobility and Welfare

Tom Krebs, Pravin Krishna and William Maloney

No 7056, IZA Discussion Papers from Institute of Labor Economics (IZA)

Abstract: This paper develops a framework for the quantitative analysis of individual income dynamics, mobility and welfare. Individual income is assumed to follow a stochastic process with two (unobserved) components, an i.i.d. component representing measurement error or transitory income shocks and an AR(1) component representing persistent changes in income. We use a tractable consumption-saving model with labor income risk and incomplete markets to relate income dynamics to consumption and welfare, and derive analytical expressions for income mobility and welfare as a function of the various parameters of the underlying income process. The empirical application of our framework using data on individual incomes from Mexico provides striking results. Much of measured income mobility is driven by measurement error or transitory income shocks and therefore (almost) welfare-neutral. A smaller part of measured income mobility is due to either welfare-reducing income risk or welfare-enhancing catching-up of low-income individuals with high-income individuals, both of which have economically significant effects on social welfare. Decomposing mobility into its fundamental components is thus seen to be crucial from the standpoint of welfare evaluation.

Keywords: income mobility; labor market risk; social welfare (search for similar items in EconPapers)
JEL-codes: E2 J6 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2012-11
New Economics Papers: this item is included in nep-dge
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Income Risk, Income Mobility and Welfare (2013)
Working Paper: Income risk, income mobility and welfare (2012)
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